The economic loss rule provides a limitation on damages in cases alleging both breach of contract and certain other causes of action sounding in tort, by precluding a party’s recovery of damages when the only economic loss is the subject matter of the contract. As the Texas Supreme Court held in Chapman Custom Homes, Inc. v. Dallas Plumbing Co., a party asserting a breach of contract action cannot recover for economic losses for various tort causes of action which “arise from the same transaction.” Chapman Custom Homes, Inc. v. Dallas Plumbing Co., 445 S.W.3d 716, 718 (Tex. 2014); see also MEMC Pasadena, Inc. v. Riddle Power, LLC, 472 S.W.3d 379, 397 (Tex. App.-Houston [14th Dist.] 2015, no pet.)
For example, the 11th court of appeals in Guerrero-McDonald v. Nassour clarified that a plaintiff suing for breach of contract may not bring a claim for negligent misrepresentation unless the plaintiff can establish that she suffered an injury that is “distinct, separate, and independent” from the economic losses recoverable under a breach of contract claim. Guerrero-McDonald v. Nassour, 516 S.W.3d 198, 210 (Tex. App.-Eastland 2017, no pet.) (citing Sterling Chemicals, Inc. v. Texaco Inc., 259 S.W.3d 793, 797-98 (Tex. App.- Houston [1st Dist.] 2007, pet. denied).
In operation, the rule “restricts contracting parties to contractual remedies for those economic losses associated with the relationship, even when the breach might reasonably be viewed as a consequence of a contracting party’s negligence.”
Here is a closer look at this rule and when it applies — as well as the exceptions to it.
The History Behind the Economic Loss Rule
As discussed by Dix W. Noel in the Vanderbilt Law Review, the economic loss rule was viewed historically as a limitation of damages that otherwise would allow for recovery by a plaintiff for reliance of a negligent misrepresentation that was not made to him or on his behalf. The reasoning expressed by the courts in upholding this rule is the theory that indirect economic consequences of negligence theoretically are virtually unlimited; or, as expressed by Justice Benjamin Cardozo in Ultramares Corp. v. Touche, would result in “liability in an indeterminate amount for an indeterminate time to an indeterminate class.”
Reasoning that economic losses, unlike negligent acts that cause physical injury, are indeterminate, and may extend to third parties whose losses may not be foreseeable, Texas courts have determined that risks of economic loss are well suited to allocation by contract. The rationale often cited in opinions such as Lan /STV v. Martin K. Eby Construction Co. Inc. is that plaintiffs are able to assess and manage the risk of economic loss and protect against it by contractual terms or by obtaining insurance.
Economic Loss Rule Exceptions
There are exceptions to the economic loss rule, which are based on an independent theory of recovery not associated with or arising out of a breach of contract, such as negligent misrepresentation by a professional. In Belt v. Oppenheimer, Blend, Harrison & Tate, Inc., the Texas Supreme Court held that while legal malpractice sounds in tort, a client can recover purely economic losses from a negligent lawyer, regardless of whether the lawyer and client have a contract.
Other exceptions include products liability cases where a defect causes more than an economic injury to the product itself, as addressed in Signal Oil & Gas Co. v. Universal Oil Products., which held, “Where such collateral property damage exists in addition to damage to the product itself, recovery for such damages are recoverable under Section 402A of the Restatement (Second) of Torts as damage to property or under the Texas Business and Commerce Code, Section 2.715, as consequential damages for a breach of an implied warranty.”
Another exception is fraud or fraudulent inducement, because, as noted by the Texas Supreme Court in Formosa Plastics Corp. USA v. Presidio Engineers and Contractors, “it is well established that the legal duty not to fraudulently procure a contract is separate and independent from the duties established by the contract itself” and “a fraud claim can be based on a promise made with no intention of performing, irrespective of whether the promise is later subsumed within a contract.”
Recent Analysis by the Texas Supreme Court
More recently, the Texas Supreme Court in White Knight Development , LLC v. Dick B. Simmons and Julie M. Simmons recognized a narrow exception to the limitations for the recovery of damages in a breach of contract action. The Supreme Court reversed the court of appeals after it modified the trial court judgment to delete the award of consequential damages, instructing the appellate court to further consider the issue of damages after the trial court awarded a judgment for both specific performance and consequential damages.
Recognizing that “the goal is to put the plaintiff back to the position it would have been in had there been no breach,” the Supreme Court agreed with the trial court’s equitable monetary award, which it determined was necessary to put White Knight in its pre-breach position, because specific performance would not address the monetary loss between the breach and the judgment. The Supreme Court instructed the appellate court that in order to be recoverable, “[e]ach category of expenses awarded must be (1) directly traceable to the defendant’s delay in performance, (2) foreseeable at the time of contracting, and (3) commercially reasonable.” It “must also be incurred in connection with the care and custody of the particular property in dispute.” Because an award for specific performance would customarily preclude an accompanying award of consequential damages, this decision and the anticipated opinion of the Tenth Court of Appeals should be closely watched by attorneys seeking contract damages on behalf of their clients.
In sum, attorneys pleading both breach of contract and a cause of action sounding in tort must carefully consider the nature of the breach or injury from which the plaintiff’s damages arise. In reviewing a damage model, both parties should ascertain whether the damages are foreseeable and a direct consequence of a breach, and whether the damages asserted are recoverable under a separate and distinct injury. An analysis of damages should also include whether the party suffering harm is fully compensated by the damages awarded, while taking into consideration the factors enumerated by the Supreme Court in White Knight Development.
Hon. Margaret “Meg” Poissant is a mediator and arbitrator at Miles Mediation & Arbitration and trial attorney who served as a Justice Justice on the Fourteenth Court of Appeals from 2019 to 2024.